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Saturday, 4 February 2012

My First Tryst With Scuttlebutt: Cera Sanitaryware

After reading the title of my blog, many of you would have been perplexed by this relatively unknown word called "scuttlebutt". What does this word mean and how is it relevant to a value investor? I will first summarize the concept of scuttlebutt and then talk about my findings for Cera while I applied this method.

Scuttlebutt term was first phrased in investing by legendary investor Mr.Philip Fisher in his seminal book "Common Stocks, Uncommon Profits". Scuttlebutt simply means finding out from the real, "Main Street" sources if the business/firm is good or bad. The central idea here is that, customers,dealers, suppliers, competitors and employees of the firm do possess some very useful and authentic information about the operations of the company and management. This information can help investor gauge certain business traits, company's position in competitive landscape and overall impression of the company with its various stakeholders. He suggested that such information is far more authentic than the assumptions and inferences drawn by Wall Street analysts who,many a times, have no connections with various stakeholders in business operations.He suggests that "business grapevine" is a very powerful tool for investors if applied intelligently.

So, After reading about this fairly common-sensical approach, I decided to venture into it and try it for one of my portfolio companies and see how accurately I have been able to judge the position of the company. I picked Cera Sanitary ware for several reasons. First, Cera has a well established dealer networks and retail presence hence I can get the information relatively easily by visiting nearby dealers/retailers. Secondly, it offers products which is used by all my relatives,friends and acquaintances hence seeking and opinion on Cera's products and gauging their preference may be easier. Lastly, Cera has manufacturing set up located near Ahmedabad and hence, if required, I can go and visit the company to get a sense of the operations. Once I zeroed in on the company, I located dealers, retailers of the company. I also found that some of my relatives/friends have bought new sanitary wares and I tried to understand from them the decision making process while they bought sanitary ware. Following are my observations from this small little investigative journey.

I went to 7-8 different retailers posing as customer wanting to renovate his bathrooms and hence is in need for sanitary ware products. I checked with them that I want decent quality yet elegant products at reasonable price. Almost all of them suggested me Cera and Hindware, in that perticular order. On further probing many of them suggested Cera would be a good fit considering "value-for-money". They also indicated that Cera & Hindware are the fastest moving sanitary ware brands for them.

Almost all retailers suggested that, there was no difference in quality at all between Cera and Hindware and hence both were equally good. Both Cera and Hindware offer life time warranty and have very good support services in case of need for repair/replacement.

I found that Hindware products are generally priced at premium to Cera and most dealers justified the difference in prices by saying that Hindware is an older brand and has pan-India presence and hence they are charging premium.

Most of the retailers suggested that in terms of bath fittings (faucets), Jaguar is the best in terms of quality and style. No other brand comes near to that.

In my interaction with 2 Cera dealers, they indicated that both of them are very satisfied with their relationship with Cera. The business is brisk and dealership margins are decent. They also indicated that Company supports them very well in terms of delivery time, product range and bulk orders. Icing on the cake is annual foreign trip for dealers, which they and their family look forward to every year. They are very optimistic about future business of Cera.

Another thing I found from retailers/dealers was that both Cera and Hindware are going to raise prices for their product by 10% from first week of February. This will be a positive for maintaining margins for them as their margins have come down in Q3 for both Cera and HSIL. I probed them further on impact of price hike on demand and almost all of them suggested that it will not have any impact on demand. They attributed this price inelasticity to changing preference for more elegant sanitaryware products and increasing willingness to spend on branded sanitary ware.

Finally, I interacted with end customers who recently made purchase decision for sanitary ware. Out of 3 acquaintances, ( i know it is too small a sample size, but can't do anything about it!) 2 of them bought all the products from Cera while one of them bought some Cera products while some unbranded products. All the three customers provided rationale for buying Cera as "value-for-money" products and "good quality"

It competes directly with Hindware (HSIL), however Hindware commands slight premium (15-20%) due to larger brand equity. In the longer run, Cera has room to increase its prices as it offers equally good quality, design and support services.

Cera operates in a relatively price inelastic market and hence shall be able to protect its margin by passing on increase in cost to customers (unless one of the competitors and mainly Hindware decides to cut its own profit margin).

Jaguar's has dominant position in faucet ware market and hence I am not sure about how well Cera will be able to penetrate this market. I will be closely watching management's take on faucet ware performance.

Thanks for compliments. Yes, I feel scuttlebut is a very useful tool if applied correctly especially in the case of business which have brands and distribution network (as it is easier to get responses from various stakeholders).

Currently reading Mohnish Pabrai's Dhandho Investor and am liking it very much. If you have not read, it will be a good read.

Hi Dhwanil, nice to see someone applying scuttlebutt approach, brings so many new perspectives.

I am also tracking Cera, and luckily came across your blog while searching for Cera.

Few doubts I had:1. You mention that HSIL has pricing power, charges 15-20% premium over Cera. Still, its profit margins and ROE are much lower than Cera. Surely Glass division can't be holding back HSIL's performance to such a large extent. What could be possible reasons for Cera's superior performance?2. Cera doesn't generate much free cash flows, hardly any if we consider a period of 5 years or more. So, how do you factor that into the projections and valuation?3. HSIL is also expanding quite aggressively - from 2.8 million pieces to 5 million pieces. http://www.business-standard.com/runup/news/hsil-to-invest-rs-650-crcapacity-expansion-in-3-yrs/135655/onWouldn't that create a situation of oversupply and cause lower profitability for Industry as a whole?

First of all, your blog is equally interesting and "widening the moat" is a wonderful name!

Regarding your queries on Cera, following is the point wise reply.

1) HSIL has a very strong brand of Hindware and it is much older and more widely recognized than Cera. HSIL also has much deeper reach and "premium" image which helps them charge higher than Cera. However, in terms of margin and ROE, it does suffer due to lower margins/ROCE for container glass division. If you look at FY11 ROCE (as reported segment wise and before interest and tax), it is 22.8% for building materials while 13.8% for container glass. Now sales mix is 50/50 which impacts margin/ROCE significantly. Moreover, Cera is one of the lowest cost producer in branded sanitaryware segment which leads to superior margins.

2)In order to calculate free cash flow for any company (for valuation), one should divide capital expenditure in two parts namely maintenance capex and growth capex. Maintenance capex is capital expenditure necessary for maintaining current level of business activity and market share. It shall not include expansion of capacity which will contribute towards growth. While counting free cash flow, one should focus on maintenance capex and not growth capex. Generally in manufacturing industry, maintenance capex is equivalent to depreciation. Rest is growth capex. If, I look at cera, my perspective is that company is plowing back free cash flow for growth and hence it will be misleading to assume that Cera does not have free cash flow generation. Next step of this analysis should be, If cera is redeploying free cash flow in business, is management generating sufficient return on money plowed back? In case of cera, the answer is emphatically yes as its ROCE/ROE is increasing. However one catch here is, if you are deducting only maintenance capex for calculating FCF, don't take very high growth rate for long period of time (10-12% for 5-7 years).

3) I do not see oversupply situation for two three reasons - in India. Replacement demand for sanitaryware only represents 10% of total sanitaryware sales while in other countries it represents 60-80%. As Indian market matures, India is going to catch up with global trend increasing the market size substantially.

- Branded sanitaryware segment is expanding by eating into market share of local/unbranded sanitaryware players. People have turned style/quality conscious which is helping branded sanitariware players (I have visited many new constructions coming up in Ahmedabad, and most of them have bathrooms fitted with branded sanitaryware, clearly representing consumer's preferences )

- HSIL's expansion plans are spread over 3 years and will also include tiles manufacturing which does not compete with Cera products. Considering that India is one of the least sanitized country (even less than pakistan and bangladesh), I do not see over capacity as an issue.

I hope, I have been able to partially answer your questions.

Best RegardsDhwanil Desau

P.S.: I am also invested in Swaraj engines and had very similar investment rationale as described by you in your blog.

I have dug more on why HSIL makes such low returns on capital as compared to Cera. Even if I just look at Sanitaryware segment of HSIL, its ROA is below Cera's. One reason you have pointed out is Cera is much more cost efficient and has better margins.

Another thing I can note is that Cera generates huge income from trading business (outsourcing). Outsourcing revenue was 109 cr in FY 2011, which is ~ 44% of total revenues. And this trading business doesn't require much capex; so this could be a big factor in Cera's superior performance.

Hi everyone,I am very happy to contact to landmaark why because they had provide quality marbles and tiles. Marble tiles are very clean looking good and superb. Landmaark is the best company about fitting dealers and flooring tile dealers. Landmarks is the top company in Bangalore to sell the materials, marbles, tiles cement etc. Sanitary ware dealers-Hindware

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About Me

Hi, I am currently working as a consultant in energy sector with focus on sustainable development. Since last 3 years I have been fascinated with the value investing philosophy and trying to put that philosophy into practice for last 2 years.